Sept/Oct 2009

Eye on Business

Some implications of the U.S. climate change legislation for oil sands producers

By
R.G. Powers and A.E. Derksen

Commodity prices, market availability and costs have always had a direct effect on the scale and pace of Canadian oil sands project development. Over the years, social, political, legal and regulatory issues relating to such things as water use, land use, social impact and community health have increasingly contributed to project costs. However, climate change legislation emanating from the United States, partially influenced by the debate over “dirty oil,” could have an even greater impact upon the development of oil sands projects in the future. Such legislation could limit or even curtail access by oil sands products1 to the U.S. market, which currently is the only viable market.

The U.S. measures

Of particular concern are three laws: the Energy Independence and Security Act (EISA), the American Clean Energy and Security Act (ACESA) and California’s Low-Carbon Fuel Standard (LCFS) (collectively, the “U.S. measures”). The Energy Independence and Security Act was signed by President Bush to become law in December 2007. Of concern to the oil sands industry is section 526, prohibiting U.S. government agencies, including the military, from procuring fuel that is produced from “non-conventional petroleum sources.” The concern is that section 526 might be interpreted broadly so as to exclude oil sands products from use by U.S. government agencies. While federal U.S. agencies currently consume a small proportion of total daily U.S. oil consumption, oil sands products are commingled with regular crude in the distribution chain and would therefore need to be separated — a difficult and costly undertaking.

The American Clean Energy and Security Act, currently before the U.S. Senate, aims to cut greenhouse gas emission levels via a cap-and-trade system, to a level that is 83 per cent below 2005 levels, by 2050. ACESA would lower the margins of U.S. refiners of oil sands products, making such products less competitive against lower cost sources such as Middle Eastern oil. ACESA could also levy “carbon tariffs” on imports from countries without analogous GHG legislation in place. The carbon tariff provisions could force U.S. trading partners, such as Canada, to adopt similar legislation, targeting heavy domestic emitters such as oil sands producers.

In California, a Low-Carbon Fuel Standard applying to transport fuel comes into effect on January 1, 2010. The LCFS requires that carbon content in fuel be reduced by 10 per cent from current levels by 2020, with further reductions required thereafter. The LCFS would penalize the oil sands products by making their usage much more costly. Other states have been examining the LCFS, with Oregon introducing an LCFS modelled on the California standard in spring 2009.

NAFTA and the WTO

The U.S. measures may or may not be compliant with U.S. international trade obligations. A WTO paper suggested that carbon tariffs could, in theory, be compatible with WTO and GATT rules, provided that they did not violate the core principle of non-discrimination, but in practice, it would be hard to prove they were not an illegal disguised restriction on international trade.

A NAFTA Chapter 11 case could also be attempted against the U.S. measures. However, previous NAFTA Tribunal decisions dealing with similar facts indicate otherwise. In Methanex Corporation v. United States of America, a NAFTA Tribunal upheld a California law banning methanol, a feedstock used to make MTBE, a gasoline additive (the law was enacted for purposes of environmental protection).3 Methanex, the Canadian complainant, argued that the California law in effect barred them from the Californian market and violated Article 1102 (national treatment), Article 1105 (treatment in accordance with international law) and Article 1110 (a measure tantamount to expropriation without compensation). The tribunal said that because the ban applied to all methanol producers (i.e. in California and outside of it) and because non-discriminatory regulation for a public purpose enacted in accordance with due process was permitted under NAFTA and International Law, the law did not violate NAFTA.

Alberta’s response

Alberta and the oil sands industry have lobbied hard to improve the oil sands’ image and counter the negative aspects of the U.S. measures.4 A recent report commissioned by the Alberta Energy Research Institute has concluded that on a full life-cycle basis, GHG emissions from Canadian synthetic crude against other heavy oils refined in the United States compare favourably. In order to reduce GHG emissions, Alberta has committed $2 billion in funding to advance carbon capture and storage (CCS) technology — an unproven technology but one that the oil sands industry hopes will significantly reduce GHG emissions. In any case, social and political pressure to improve the environmental performance of oil sands operations continues to grow.

Conclusion

While the U.S. measures have yet to directly affect exports of oil sands products to the U.S., it is clear that U.S. policy is changing and could significantly impinge upon such exports. Canadians have tended to assume that the U.S. market would always be open to oil sands products. However, if the U.S. measures make Canadian oil sands products less competitive in the U.S. and if CCS or other GHG-limiting technologies prove unviable, then that belief will have to be re-evaluated and other options, such as a West Coast pipeline opening access to East Asian markets, may become more attractive and may need to be considered.

Greg Powers is a partner in Fasken Martineau’s Calgary office. His practice is focused on oil and gas, securities, mergers and acquisitions, corporate commercial and project finance. His experience includes advising private and publicly listed clients on issues related to acquisitions, investments and joint venture structures in connection with conventional projects and projects for the extraction and upgrading of heavy crude oil and bitumen.

Andrew Derksen is an associate at Fasken Martineau in Toronto and is part of the Global Mining and Energy Group. His practice focuses on corporate, commercial, international and securities law matters.